What the New Cost-Basis Legislation Means for You
Under the new rules, brokers will be required to track and report purchase prices.
Question: I've heard that my broker is going to have to start tracking my cost basis and reporting the information to the Internal Revenue Service. Does that mean I can get rid of my cost-basis spreadsheets?
Answer: The topic of cost basis tends to elicit headaches or blank stares from most investors. But cost basis isn't all that complicated. Put simply, your cost basis in your investments is the purchase price, adjusted for dividend and capital gains distributions as well as stock splits, commissions, and other fees. Cost basis has important tax implications. That's because the difference between your cost basis and the current selling price of your security determines your profit or loss as well as how much you owe the government in taxes (or how much you can claim in deductions for capital losses).
Here's a simple example. Say you take advantage of your brokerage firm's commission-free trading and buy shares of a non-dividend-paying stock for $12 per share; you sell two years later when the stock is at $25. Assuming this trading was going on in your taxable account, you'll owe taxes on the capital gains of $13 a share, but you won't owe taxes on your original $12--your cost basis. Of course, cost basis isn't always so straightforward, especially given that many people purchase the same security at multiple intervals via dollar-cost-averaging. In such instances, people can calculate cost basis in more than one way. For example, they can cherry-pick specific lots, specifying that their broker sells their high-cost-basis securities first. Employing such a strategy can help reduce their tax bills.
Esther Pak does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.